Withdrawal comes within days of SEC Chair White and Commissioner Aguilar issuing public statements regarding ETFs.

On October 19, the US Securities and Exchange Commission (SEC) published a notice stating that NYSE Arca, Inc. had withdrawn its proposal (Proposal) to create generic listing standards for shares of actively managed exchange-traded funds (ETFs). As we discussed in previous LawFlashes on this topic,[1] listing in accordance with the proposed standards likely would have significantly reduced the time required to launch active ETFs.

By withdrawing the Proposal, NYSE Arca avoided forcing the SEC to make a determination on the Proposal at this time. By law, the SEC is required to approve or disapprove proposed rule changes, such as the Proposal, no later than 180 days after publication in the Federal Register, but the SEC may extend that period by up to 60 days if it determines that a longer period is appropriate and publishes the reasons for such determination.[2]

Commissioners Issue Public Statements on ETFs

The withdrawal of the Proposal comes during a time when the SEC has increased its focus on the ETF industry. In remarks to the Investor Advisory Committee (IAC)[3] given within days of the withdrawal, SEC Chair Mary Jo White discussed the SEC’s current efforts relating to exchange-traded products (ETPs).[4] She noted that the SEC is studying the operation of the “limit up/limit down” mechanism, including how it operated on August 24, 2015, when the markets experienced periods of heightened volatility. She further noted that the SEC is “paying close attention” to pricing issues in ETPs. Finally, she noted that the SEC staff is continuing to evaluate trading data from August 24, focusing particularly on whether the volatile trading behavior of ETPs can be explained by uncertainty in pricing of the underlying assets, the nature of liquidity demand and supply for ETPs, and/or the low trading volume in many individual ETPs.

Commissioner Luis Aguilar added to Chair White’s remarks.[5] Citing the trading issues that ETFs experienced on August 24 as an example of ETF fragility, Commissioner Aguilar stated that it may be time for an examination of “the entire ETF ecosystem.” Commissioner Aguilar suggested a number of issues for the IAC to consider, including

whether trading in ETFs should be halted whenever a “significant” number of their portfolio assets are subject to a trading halt, or whether such ETFs should be allowed to continue to trade to enable price discovery for their underlying assets;

whether the limit up/limit down rules need to be revised so that the arbitrage mechanism that ETFs use can function during periods of acute volatility without triggering an excessive number of trade halts;

whether the market-wide “circuit breakers” should be recalibrated to help markets better deal with broad-based events;

whether potential uncertainty about when trades will be broken inhibits the efficient pricing of ETFs, for example, by threatening the ability of liquidity providers to hedge their positions;

how to better ensure transparency and timeliness at the open of the primary listing markets, and what role manual procedures (such as those of the exchanges) should play;

how liquidity providers for ETFs can be better incentivized to participate during periods of extreme volatility; and

how the growth of ETFs and their proliferation into less liquid asset classes has created challenges for the ETF arbitrage and pricing mechanisms, including a consideration of whether the SEC should consider potentially curtailing the growth of ETFs.

Conclusion

NYSE Arca’s withdrawal of the Proposal and Chair White and Commissioner Aguilar’s remarks regarding ETFs follow the SEC’s request for comment on topics related to the listing and trading of ETPs in June 2015.[6] Given all that, it is clear that the SEC has made analyzing the ETF industry a focus of its efforts, and industry participants should be prepared for this regulatory attention to continue.

[2] Section 19(b)(2) of the Securities Exchange Act of 1934. The Proposal was published for notice and comment in the Federal Register on March 10. On June 5, the SEC issued an order instituting proceedings to consider whether to approve or disapprove the Proposal, as amended, and on September 2, the SEC designated a longer period of time to consider the Proposal.

[3] The purpose of the IAC is to advise the SEC on regulatory priorities, the regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure, and on initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace. The Dodd-Frank Act mandated the IAC’s creation.

[4] White, Opening Remarks to the Investment Advisory Committee (Oct. 15, 2015). The term “ETP” is generally understood to include ETFs.

[5] Aguilar, How Can the Market Best Adapt to the Rapid Growth of ETFs (Oct. 15, 2015).